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Monday, February 21, 2011

T. Rowe Price has produced an important study entitled "Dismal Decade Offers Cautionary Lessons for Retirees" that DIY Investor believes all who are interested in a comfortable retirement should read. If you are within 5 years of retirement or in retirement, then read it now. Otherwise, copy it, put it in your "stuff to read when I'm 60" folder and go back to building your nest egg. As I remind my community college students (this is actually news to some of them), "you are allowed to read stuff more than once." Read this short - 3-page study - until you "get it."

The T. Rowe study examines different responses to a downturn in the market at the time of retirement. Consider that you have just retired with a fat nest egg and the market goes off a cliff twice in the next 10 years while you're trying to manage withdrawals from your nest egg. The case study is those who retired in 2000. Prior to that time, the stock market had been exceptionally generous. From 1995 through 1999, as the study points out, stocks achieved gains exceeding 20% each year. Subsequently, the decade following, which we have just finished, saw one of the worst performances ever as it experienced two serious downturns.

The study looks at 4 possible nest egg withdrawal responses on the part of year-2000 retirees and addresses the #1 question of retirees: what are the chances of running out of money - incidentally, the #1 fear of seniors. I'm not going to reveal the outcome because everyone should read this study; but I will reemphasize that this is very practical information that potentially could save people's retirements, depending on where markets go from here.

As a practical matter, DIY Investor believes that nothing is really lost if you skip the explanation of the Monte-Carlo analysis. As I tell my students "this part won't be on the test." Those with a mathematical bent will like the Monte-Carlo explanation, but suffice it to say that T. Rowe looked at a lot of different possible paths in generating their results in terms of where the market goes in the future.

I do want to put in one picayune sort of point that emphasizes that retirees need to keep an open mind and examine possibilities even their financial planners might not consider or present. Financial planners are human and, like the rest of the world, emphasize the recent past. But the recent past, as market observers know, isn't always a good guide to the future. With this in mind, let's go back to 1/3/2000, after the stock market has gone on a tear and investors are sitting on fat portfolios. At that point, the yield on the 10-year U.S. Treasury was 6.58% . Today that yield stands at 3.60%, i.e.yields were considerably higher. A good recommendation on 1/3/2000 would have been for the newly retired to consider putting up to one-third of their fat portfolio into a single premium, immediate pay annuity. This would have locked in an income stream that would have covered some of the basic needs of the newly retired and, thereby, brought down the stress level that the market ahead was going to produce and greatly change the results in the T. Rowe study. That is - the probability of running out of money in the four scenarios would have been greatly reduced.

Granted, this is offered with the benefit of perfect hindsight; but the purpose is to keep an open mind. We very well could be moving into a higher interest rate environment that could offer annuities at attractive levels.

A second point I can't resist is that readers of this blog know not to just take a percentage of portfolios as a withdrawal strategy in retirement. This subjects the retiree to the negative impact of "reverse dollar cost averaging." Having a withdrawal plan in the decumulation stage would lessen the negative impact found in the T. Rowe study.

Disclosure: I don't sell annuities or receive any compensation for any type of financial product. I am fee-only and the only compensation I receive is that paid to me by my clients.

9 comments:

@MoneyCone What I like about it is that most people who are interested in the subject can understand the study and its conclusions. Too many of these kinds of studies are written for experts and the layman has no chance of getting at what they mean to him.

It's a shame this decade was so tough on so many people. If only they had 1) taken those huge winnings from the 90's and rebalanced with bonds to lock in those gains and 2) retired early, say 92-94 rather than 2000, things would be much different. From what I've read, the first few years of your retirement are the most crucial for longevity. Get a few bull years in the beginning, it's smooth sailing. But run into a bear, and reverse dollar cost averaging will wreck your portfolio.

It's true, and that herd mentality can dramatically alter people's behavior. If they had rebalanced regularly and stuck to conservative allocations (assuming we are still talking about those in or near retirement) things might be different. I read about a woman who was a secretary at AOL during the boom and had stock options worth 1.7 million. Let's just say she can't retire on what they are worth now...

Some good literature from Maryland based T. Rowe Price. Though they are a for profit mutual fund company, they don't gouge their investors as much as some and provide conservative, level-headed financial advice.

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I've managed investment assets for institutions and individuals for more than 30 years and have seen first hand the egregious fees charged for sub par performance. My mission is to show individuals how to avoid these fees and capture the long term performance of the markets. In doing this I consult on an hourly basis, manage assets for a short period to get investors set up to manage on their own and manage assets outright at less than half the going rate.
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